Conclusions: Using finance to drive climate solutions

Sergio Scandizzo and Tony Hughes

In this book, we discussed the current debate on climate-related financial risk while also trying to give an idea of the modelling solutions available and of alternative ways to look at regulatory policies.

Current climate stress tests for banking operations typically mirror traditional stress tests in that they assume that banks hold static portfolios. Such an approach may be reasonable for short-term scenarios such as recessions, but it fails when applied to longer horizons typical of climate change analysis. As climate risks unfold over decades, banks and companies are not static; they will adapt, relocate or change strategies, thereby altering their exposure to risk. A dynamic portfolio model in climate stress testing would better account for such adaptive behaviours, leading to more accurate assessments of long-term risk and the potential for companies and banks to mitigate losses by exercising options such as relocation. In doing so, much of the physical risk assumed under static models might be avoided, that makes the current stress test results potentially overly pessimistic.

We noted moreover that historically, climate-related disruptions, such as natural disasters, have had